Futures Options Unpacked: Figuring Out the Pricing

For many, futures options have a certain mystique thanks to their steeper learning curve and pricing structures. But futures options can be accessible, tradable, and not as confusing as they look.

If you trade equity options, you’re likely already versed in the mechanics of various options strategies and the math involved. With a little effort, you can get outside your comfort zone and wrap your mind around the specifics. Unlike equity options, futures options are priced differently.

Futures options are priced off an underlying futures contract, while futures contracts (which are also derivatives) follow different pricing conventions depending on the underlying. For instance, crude oil trades in barrels, corn trades in bushels, gold trades in troy ounces, and indices have multipliers. Right off the bat, one thing is obvious—if you want to trade futures options, you need to know how the underlying works. So let’s dive in.

Equities Versus Futures

Futures are contracts—an agreement between two parties to complete a transaction on a commodity or other underlying asset or index at a certain price, at some time in the future. By contrast, equities are not contracts, they don’t have expiration dates, and their options pricing is standard. In other words, all equity contracts follow a similar pricing structure. And because futures options are priced off their underlying futures contracts, there are some nuances to be aware of.

Standard monthly equity options expire on the third Friday of each month and weekly options expire every Friday, in most cases. But futures and their corresponding options don’t expire at the same time. Some expire in the same month (i.e., December contracts expire in December). But it’s not always the case, and this can lead to some confusion. To see the differences in futures options expirations, fire up your thinkorswim® platform from TD Ameritrade (see Figure 1).

FIGURE 1: FUTURES OPTIONS EXPIRATIONS.

December contracts could expire in November, and the futures contracts and their corresponding options most likely won’t expire on the same day. Source: thinkorswim from TD Ameritrade. For illustrative purposes only.

1—Click on the Trade tab.

2—Type in the futures symbol. We’ll use crude oil contracts, /CL, as an example. The active futures contract is first, in this case the December contract. But even though it’s a December contract, futures expire at the end of November.

3—Scroll down to the option chain. The December options expire a few days before the futures contract.

For comparison, bring up the symbol for the E-mini S&P 500 futures (Figure 2). Here, the December futures contracts expire at the end of December, and December options (not the weeklys) expire at the same time as the futures contracts.

FIGURE 2: FUTURES AND THEIR OPTIONS EXPIRING ON THE SAME DAY.

In the case of indices, the futures contracts and their corresponding options expire on the same day. Source: thinkorswim from TD Ameritrade. For illustrative purposes only.

Dates vary because every commodity market is different. Grain contract expirations are based on planting and harvesting cycles. Grain options expire at the end of the month before the futures. Crude oil contracts expire every month, and the options expire three days before the futures. Bond options are the weirdest of all. They expire on the last Friday that precedes the last business day of the month preceding the option month, by at least two business days. To help you navigate this tricky path, on the Trade page of thinkorswim, the number of days to expiration is displayed next to the contract in parentheses.

Expirations mismatch for other reasons as well. Most people don’t actually want to take delivery of barrels of oil or bushels of corn. (TD Ameritrade doesn’t allow you to take delivery of the underlying.) Think of it as a grace period—a little time to decide what to do with the future if you exercise your option. And even the grace period is different for different contracts. For example, crude oil can get tricky, since the contracts expire every month. Yet you have a few days to decide what to do with your crude futures.

Don't Ignore Skew

Have you ever noticed that with equal OTM puts and calls, one may be priced significantly higher or lower? Skews aren’t out of the ordinary in equity options, where markets drop faster than they rise. But with a big drop in, say, the S&P 500 Index, you’ll likely see puts priced higher than equally distant calls. This is normal volatility skew. In the futures world, skews fluctuate often and do so in the opposite direction. Commodities generally go up faster than they go down because there’s no limit to how high prices can go. The upside tends to have an explosive nature. In fact, traders may be more willing to buy call options because vol is higher. You’ll often see this in the grain markets.

Schedules and Pricing

A futures option delivers one futures contract. So if you exercise a call option on the /ES, you’ll be long one E-mini S&P futures contract. In other words, the price of the option is based off the price of the /ES futures and not the cash index. Same for commodities. If you exercise a corn call option, you’re long one corn futures contract, not 5,000 bushels of corn. Also, futures prices on an index or commodity could have different prices in different expirations. For example, a March corn contract may be trading at $354.25, whereas a May corn contract may be trading at $362.50.

Size and Value

Commodities have different characteristics. And their futures contracts don’t all trade the same way. The pricing structure varies, with each traded future having different multipliers, tick values, and tick sizes (minimum price fluctuation). These differences can be confusing for an options trader who’s calculating how much premium she might pay or collect. To get a closer look, review the table in Figure 3.

FIGURE 3: CONTRACT SPECS OF SOME FUTURES CONTRACTS. Notice how these futures all have different one-point values? You've gotta know these specs if you wanna trade their options. For illustrative purposes only.

Peruse the Fine Print

Now that you know contract specs for some futures contracts, how can you trade their options? As an options seller, you want to consider how much premium you’ll collect, so get to know the point values.

Say you want to trade options on the June /ES. If the at-the-money (ATM) call options are trading at $96.50, the multiplier is $50 per point. So, the dollar amount of premium in this case would be $50 x 96.50 = $4,825.

For even more complexity, there are Treasury bonds. Bond futures trade in 32nds (1/32), and bond options trade in 64ths (1/64). How does that impact their pricing? Let’s take a look.

Say the March /ZB contracts are trading at 152'23 or 152 points and 23/32 of a point. Now look at the option chain. Say the ATM call options are priced at 2'45 or two points and 45/64 of a point. Multiply 2 and 45/64 by the point value, or $1,000, and you get $2,703 (45/64 = 0.703125 &plus;2 points = 2.703 x 1000 = $2,703).

In spite of contract specification differences, the mechanics of trading equity options and futures options are roughly the same. You still want to make profits and reduce risks. But you may need to modify the strategies.

When trading futures options, you’re trading a derivative of a derivative, and that means higher leverage, or more risk exposure. It’s a kind of double whammy. So as an options seller, if you sell out-of-the-money (OTM) calls, consider the contract multipliers to determine your premiums. Also consider how much or little potential profit or risk you take on when you trade futures options.

Taking the Plunge

Unlike equity options, futures options can introduce a few mysterious twists and turns. But don’t let the differences put you off. With education and experience, you can get more comfortable over time, and you don’t need to know the specs of all futures contracts—just the ones you want to trade. To smooth the way, consider keeping a cheat sheet with multipliers, tick values, and point values handy. Above all, get inside the markets you want to trade and before you know it, all those odd prices will be as familiar as a gallon of gas.

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Jayanthi Gopalakrishnan is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are soley those of the author and may not be reflective of those held by TD Ameritrade, Inc.

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